The Asian Financial Crisis in Perspective

by J. Orlin Grabbe

Tokyo had a Wild West feeling to it in
the Spring of 1989. Something was definitely
in the air. There were those ubiquitous
signs in which a young Japanese woman, her
head ringed by stars, proclaimed in
mysterious English: "I Feel Coke!"

Only a Japanese could possibly know what
was meant. But the symbolism at the bar in
the Imperial Hotel was more apparent. A
Japanese businessman sat beside me and
ordered a shot of American whiskey: Kentucky
bourbon. When the bartender poured the
shot, the businessman told him to leave the
bottle. Imported whiskey was very expensive
and clearly the drink of choice in Tokyo.
The ability to afford the entire bottle was a
macho sign of financial success. There were
even "whiskey bars", which served nothing but
whiskeys (both bourbon and scotch) from
around the world. In early evening Japanese
men in suits and ties would come staggering
out of the doors, barely able to stand.
Drinking was a social release from the
regimented corporate environment in Japan,
and there was no social stigma attached to
public drunkenness.

I was waiting to meet Galen Burghardt,
who was then working for Discount Corporation
of New York Futures, and who wanted to go eat
sushi underneath the train tracks. It struck
me as a nice change of pace here in what was
widely billed as the most expensive city in
the world. The Old Imperial Bar where I
waited was a tribute to Frank Lloyd Wright.
The original hotel was built in 1890, next to
the Imperial Palace, as both a refuge and
display case for westerners. In 1923 the
hotel added a new building, designed by the
architect Frank Lloyd Wright. Wright combined
yellow brick, greenish volcanic tuff carved
with Mayan and art-deco patterns, carpets
woven in Beijing with American Indian
designs, stone castings of birds and beetles,
and copper drains that sprayed water in
strange patterns. The new building had its
grand opening on the exact day of the great
Tokyo earthquake that leveled wide swaths of
Tokyo and Yokohama. Wright's building
survived the 1923 quake with minimal damage,
however, but was eventually condemned and
torn down in 1968. Some of the pieces of the
original were incorporated into the building
that replaced it.

I was in Tokyo to discuss banking
software. Tokyo was the place to be for any
area of finance in 1989. That year the
Nikkei 225 reached 39,0000. At its peak, the
Tokyo stock market was valued at more than
Yen 500 trillion ($3.6 trillion), or about 30
percent higher than the listed value of all
U.S. companies. There was a gold rush
atmosphere about the place. And lots of
gold, also, but not for investment. Sure,
there had been the Hirohito gold
commemorative coins a few years before, that
had caused a temporary flurry in the gold
market. But now Japanese were more
interested in consumption. Any drink with
gold flakes in it was popular--drinks like
Goldwasser. Some Japanese also sprinkled
gold flakes on their cereal. Eating gold was
another macho sign of financial success.

Prestige could be bought, and frequently
was. Being near the Emporer was prestigous.
The land around the Imperial Palace (a few
square miles) was said to be worth more than
all of California (163,707 square miles).
There were some problems, naturally, with
that calculation. Some flake had taken the
marginal cost of a square foot of land in a
recent Tokyo real estate purchase, and used
it for the average value of every square foot
in the region. But the calculation made the
point of how expensive property had become in
Tokyo. The boom was supposedly a consequence
of the accumulated savings of those born from
the late 1930s to the late 1940s, of men who
had scrimped and scrounged all their lives
and who now, in their 40s and 50s, had
decided it wouldn't hurt to spend a bit of
what they had. Every day the stock and real
estate markets added more to each
individual's wealth than the insignificant
drain brought about by whiskey and gold
flakes.

It was all driven by savings, people
said. And by technological innovation, and by
the "partnership" between Japanese industry
and government. The real money supply (the
money supply adjusted for inflation), was
booming along at a 10 percent growth rate,
but that had nothing to do with it. Land and
stock prices would always rise. So confident
were investors that stock price would always
go up, that Japanese companies were issuing
equity-linked convertible bonds with scarcely
a visible interest rate. Who needed interest
coupons, when the value of the stocks the
bond was exchangeable for was going to the
moon? Stock brokers made secret verbal
promises to large customers, "guaranteeing"
that prices would not decline.

Everyone was in on the stock game, even
manufacturing corporations. Equity and
equity-related sources of funds for
manufacturing companies rose from 25 percent
in the first part of the 1980s to 70 percent
by 1989. And what did manufacturing
companies do with the money? Forty percent
of the funds raised were invested in other
financial assets. That is, instead of
producing goods, the companies issued stock
and then used a good chunk of the funds to
purchase other financial assets. Who needed
banks, when money was available for free in
the stock market? And why bother making
widgets, when there were so many attractive
financial assets to buy with the new funds?
There was a seemingly free lunch and it was
called Stock Market Boom.

Banks, meanwhile, turned to the real
estate market. As banks' watched their
lending base to manufacturing fall (from 50
to 16 percent over the course of the 80s),
the banks turned around and lent to
households, property companies, and service
firms. And what did these latter entities do
with the money? They plowed it back into
land and stocks, because the prices of these,
everyone knew, would continue to go up. And
go up they did--just as long as the money
kept flowing in. Japanese banks expanded
around the world, financing properties
everywhere. They underwrote municipals
bonds. They bought shares in the U.S.
government, financing a good piece of the
U.S. deficit. The yen was king. Long live
the yen. And if stocks went down? Well,
that wouldn't happen. The government
wouldn't allow it.

Flash forward to Hong Kong in May 1997.

Red Chips

"Red chips" are stocks issued by Chinese
companies in the Hong Kong stock market.
Everyone wants red chips. There is red chip
mania, especially for a company called
Beijing Enterprises. Chinese companies like
this one are considered a sure bet. These
companies have political connections to the
Communist Party hierarchy in Beijing. The
Beijing bureacrats will look after the
company's welfare and will protect its share
price, investors are saying. It would look
bad if stock prices fell after the Chinese
take-over of Hong Kong, the same investors
whisper. Buying shares in Chinese companies
is not only a good investment, it's good
insurance. Everyone knows that.

There is nothing quite like Capitalists
exercising their faith in Communism. For
Beijing Enterprises is only three months old.
It is the investment arm of the Beijing
municipal government. And it owns, well, some
McDonald's restaurants in Beijing. But never
mind all that: the not-yet-issued shares
have been oversubscribed by a factor of 1200.
In fact, the issue seems to have attracted
investment capital of about HK 200 billion,
or about twice the Hong Kong money supply.
People have withdrawn so much cash as a
consequence of the issue, that Hong Kong
banks have asked Beijing Enterprises not to
cash the checks it has received--at least not
until the banks can deal with their shortage
of vault cash. That presumably will happen
when 1199 of each 1200 would-be investors,
who are not lucky enough to be awarded
shares, redeposit the money in their Hong
Kong bank accounts, and disappointedly await
the arrival of the next new red chip.

Yes, the free lunch had come to Hong
Kong in 1997. And, as in Tokyo in 1989, it
was called Stock Market Boom. And nowhere
was the boom bigger than in the stock of
mainland Chinese government companies. Some
investors explained to the newspapers that it
didn't matter if they didn't know what the
assets of Beijing Enterprises were. They
were just planning to resell their shares for
a quick profit, anyway. And how could they
be sure of a profit? Well, remember: Stock
prices always go up. And the shares of
Beijing Enterprises performed as required:
the price quadrupled in just the first day of
dealing.

The naive faith in the China connection
reminds one a little of the Stockholm
Syndrome, the name given to the phenomena of
kidnap victims adopting the point of view of
their kidnappers. Kidnappers, after all,
control every facet of their victims' lives.
The primal survival mechanisms of the kidnap
victim kick in and respond to that basic
environmental reality. Soon a kidnap victim
starts to believe his kidnapper's cause is
just. And the investors of Hong Kong likewise
started to believe that Chinese Communists
will save Hong Kong Capitalism--at least
where the stock market was concerned. In any
event, Stock Market Mania trampled disbelief
underfoot in its onward surge in search of
the sure thing.

Soon thereafter, in June 1997, trading
in red chips drove Hong Kong's Hang Seng
index above 15,000. About 50 red chips made
up 11 percent of stock market value, but had
accounted for about 25 percent of trading for
the year. China, for its part, was alarmed
at all the confidence demonstrated. It
decided to impose listing restrictions,
requiring all share issues to be reported to
the China Securities Regulatory Commission.
This was intended to impose quotas on stock
issues by Chinese companies in foreign
markets. Only companies that kept their
assets at home in China for at least three
years would be permitted stock issues.

Then the rumor spread that mainland
Chinese investors were buying into Hang Seng
bank. So the shares of Hang Seng
subsequently soared, as Hong Kong investors
rushed to imitate the wiley mainlanders--you
know, those people so well-versed in
Capitalism. Only a few months later, in
October, as the Hong Kong market crashed
below 10,000, there would be references to
the Asian "disease", a supposedly mysterious
financial flu that was spreading from Hong
Kong to Wall Street. Clearly, there was a
Hong Kong disease, but it was not any
different from the Japanese disease of 1989.
Or the Wall Street disease of 1997. The
disease was Stock Market Mania and wildly
inflated stock values. The inevitable result
of the mania was a collapse of prices as the
money flowing into the market could no longer
be sustained. The money flows had followed
the vision, the belief in ever-rising prices.
But once the money ran out, the self-
sustaining nature of the vision collapsed
along with demand for stocks.

I have a 1913 bond certificate that I
keep around for perspective. The bond was
issued by the Government of the Chinese
Republic: the 5 percent gold loan of 1913
for the Lung-Tsing-U-Hai Railway. The
financing was remarkably international for
the day. The bond certificate is printed in
both French and English. The loan is
denominated in British pound sterling. And
the bonds were issued in Brussels.

I purchased the bond certificate
complete with some associated coupons,
payable every six months on January 1 and
July 1, from January 1943 to January 1961.
No one had ever tried to collect these
coupons, because there was no point to the
attempt. The loan had been rescheduled to
1/2 percent in 1936, with interest payments
rising gradually to 4 percent in 1941 and
thereafter. But then the war intervened, and
payments ceased altogether. And there was a
revolution in China. And somewhere, some
small investor who had expectations of an
easy life of clipping coupons until the Year
1961 was forced to abandon his vision and
return to the drawing boards.

Foreigners who put their faith in China
are apt to be disappointed.

Wasabi

Back in Tokyo in 1989, life underneath
the train tracks seemed an alternative
reality--a Japanese underground operating
beneath the techno-veneer. People seared
meat over open fires. Tarpaulin-covered
entry ways revealed stairways leading to
underground rooms beating out rock music.
Artisans hawked their wares, much like on
Berkeley's Telegraph Avenue. Galen and I
crowded into the counter of a small diner
and pointed to the sushi dishes we wanted. I
had to insist on extra wasabi. Young
Japanese raised their beers in salutes.
There was the same upbeat atmosphere here as
everywhere else. Tokyo was a happening
place, and everyone knew it.

The Nikkei 225, floating at 39,000 in
1989, fell 64 percent by mid-1992. Property
prices had dropped by a similar amount.
Neither the whiskey nor the gold flakes nor
the infectious hubris was able to keep prices
pumped up. Some blamed the fall on monetary
restriction, but monetary policy had
mysteriously tracked the mania rather
precisely, making it difficult to tell which
was cause and which was effect--except by
prior conviction. The rate of growth of the
real money supply had fallen to minus 2
percent by 1992, a year in which industrial
output fell by 8 percent, the worst since the
oil-shocks of the mid-1970s. And the drop in
land and stock values had already put the
banking system into jeopardy. Corporate stock
held by Japanese banks is counted as part of
bank capital: 55 percent of unrealized stock
capital gains can be applied to the 8 percent
Basle banking capital ratio. Thus bank
capital fluctuates with the stock market.
This was one of the reasons the Ministry of
Finance in early 1993 used money from the
postal savings system to purchase stock in an
attempt to bolster stock prices. The absurd
notion appeared to be: "If we just spend
more funds on the purchase of stock in the
secondary market, the banks will be better
capitalized." Accounting prestidigitation.

By 1994 Japanese companies had begun the
process of redeeming Yen 14 trillion ($140
billion) worth of convertible bonds. They
discovered that in a stock market environment
where prices went down as well as up, they
had to pay real interest. Few bondholders
were converting their bonds into equity,
because the cash principal of a bond was more
valuable than the stock it was tradable for.
So companies had to pay back real money
instead of printing it in the form of new
equity. The seeming free lunch was over.
But the pain was only beginning. Up until
then, the engine of a huge trade surplus
($118 billion in 1992) had kept Japan out of
deep recession. But this trade surplus was
threatened by a rising yen, which hit Yen 100/$
in June 1994. The U.S., which the previous
year had enacted the biggest tax increase in
U.S. history, meanwhile urged Japan to cut
its own income taxes, and to not go through
with a contemplated 3 percent increase in
consumption taxes. (The U.S. excels in
prescribing cures for other countries.)
Deflation in Japan was well underway:
wholesale prices had been falling for two
years. Banks eagerly looked for the
resumption of the boom that would again buoy
stock and land prices, and bail them out of
their problem loans. They waited, and fudged
their accounting records, but the boom never
appeared.

By 1997 the Japanese banking problem had
been growing for years. Only a fool would
believe it could be fixed overnight. At the
beginning of the year, 9 out of 10 of the
world's largest banks--in terms of loans
outstanding--were Japanese. That's a funny
measure: loans outstanding. It's easy to make
loans. Collecting on them is another matter.
And Japanese banks had a notoriously poor
return on assets. But they were the mainstay
of project financing in Hong Kong and
Thailand (just as Korean banks were critical
to Indonesia). A Japanese banking crisis is
Thailand's problem and Hong Kong's problem,
and Indonesia's problem also, not just
Japan's. Japanese banks, for example,
provided 30 percent of the first syndicated
loan for Hong Kong's new airport. They also
supplied capital to Japanese manufacturers
setting up shop in Thailand. At the end of
1996, Japanese banks had $37 billion on loan
to Thailand and $22 billion to Indonesia.

In all, Japanese banks were sitting on
$250 billion of problem real estate loans.
And capital ratios had also worsened as stock
market values fell in line with property
values. How much capital ratios had fallen
was difficult to say. For one bank, Yasuda
Trust, the unrealized stock gain contribution
to bank capital apparently went to zero when
the Nikkei hit 18,200. Fuji bank's hit zero
at 16,100. Other banks--like Sumitomo,
Sakura, and Tokai--topped up their capital by
simply issuing new shares in the already weak
stock market.

Wouldn't it be a nice time to deregulate
the banking system? Prime Minister Hashimoto
asked. Everything else had failed. Why not
attempt some market discipline? Work began on
Japan's "Big Bang", or some PR to that
effect, anyway. Japan's deregulation of the
financial sector was to be completed by 2001,
along with deregulation of telecommunications
and the electrical industry. The banks had
loved being regulated, of course. It had
kept the interest rates they had to pay on
deposits low. And it had kept out foreign
competition: since each new banking service
had to be approved by the Ministry of
Finance, foreign banks could not enter the
market with new financial products (such as
securitized mortgages) that had been
developed and tested elsewhere.

The banking sector was not the only
problem area. In April 1997, Nissan Mutual
Insurance Company--Japan's 16th largest life
insurer--collapsed, highlighting the problems
that existed in the insurance sector also.
The insurance industry controls about one-
eighth of Japan's savings, including pension
money. The problems for Nissan's collapse
were much the same as those for the banks:
poorly managed exposure to the property and
stock markets. It was the first Japanese
insurance company since World War II to go
under. Nissan had caught the stock market
fever also. It sold bonds offering what were
relatively high rates of interest for Japan.
These bonds were collateralized with real
estate and equities, whose price was expected
to appreciate by more than the interest rates
paid on the bonds. But then land and stock
prices collapsed, and Nissan Life was stuck
with depleting its capital in order to meet
its interest payments. When it went under,
Nissan's liabilities exceeded its assets by
200 billion yen. Some estimate that the
entire Japanese life insurance industry was
insolvent by 1997.

Then in November, the financial
institutions began falling like dominos:
Sanyo Securities, Hokkaido Takushoku Bank,
Tokuyo City Bank, and Yamaichi, one of the
"Big Four" security firms. Yamaichi, the
former chairman Tsugio Yukihira admitted, had
been bankupt for several years. Yamaichi had
promised some investors a guaranteed return
on corporate stock, and had eaten the stock
losses, hiding away the losses in offshore
corporations in the Cayman Islands. The
hidden loses appeared to be about $2 billion
(Yen 264 billion). Concealment had been going on
since 1991. "If my company had disclosed
problem assets," Yukihira explained, "it
would not have been able to survive." But
hiding the problem assets had not kept the
money going out the door from exceeding the
amount coming in. Once all the firm's
capital was depleted and no more could be
borrowed, there was nothing to do but shut
the doors anyway.

The "Japan premium"--the country premium
above the U.S. Treasury yield that Japan pays
to borrow dollars--increased to as much as
four percentage points for still going
institutions like Nippon Credit Bank. The
debt of other banks, such as Yesuda Trust's,
was downgraded to junk status by the U.S.
rating agency Standard & Poors. Two-thirds
of all Japanese corporations had reported
losses in the latest fiscal year. That was
believed to be a simple reaction to Japan's
effective 50 percent corporate tax rate--much
higher than all its neighbors and
competitors. But maybe not. Maybe the
losses were real.

The closing of Yamaichi was the most
recent episode of a continuing melo-tragedy
that had begun earlier in the summer in
Thailand.

One Night in Bangkok

The value of the Thai baht was the first
to do. Thailand called in the IMF at the end
of July 1997. At the beginning of the month,
the Bank of Thailand floated the baht, and it
fell 25 percent or so against the dollar over
the course of the month. When the IMF was
approached, the governor of the Bank of
Thailand promptly resigned, following by the
"permanent" secretary at the finance
ministry. A few months later, the Prime
Minister, General Chavalit Yongchaiyudh,
would also resign.

Some blamed it all on Soros Fund
Management, which was believed to have sold
large amounts of baht forward. But if George
Soros didn't exist, he would have had to have
been invented. The currency was sure to
depreciate one way or another. The process
was an old story. The Thai baht was pegged
to a basket of currencies, the principal one
of which was the U.S. dollar. So local
companies and financial institutions,
operating under the assumption the central
bank would absorb all foreign exchange risk
(the free lunch), borrowed in foreign markets
at low intererest rates, and plowed the money
back into local real estate. There was a
building boom, a speculative property bubble.
Between 1991 and 1996 Thailand's foreign debt
rose from $18 billion to $62 billion. Credit
extended to the private sector rose from 88
percent of Gross Domestic Product to 135
percent.

When the baht fell against the dollar,
the value of foreign debt increased (that of
Siam Cement, for example). The central bank
also raised interest rates to make baht
deposits more attractive, and this further
squeezed property developers and those who
financed them. Other Thai companies also
found themselves unable to meet their debt
payments, and the banks who lent to them were
hurting. In October, spreads on sovereign
Thai bonds were 500 basis points (5
percentage points) over U.S. Treasuries--a
level at which coporate junk bonds could be
expected to trade. In November, Advance Agro,
a Thai pulp and paper company which had most
of its costs in baht and most of its revenues
in dollars, issued 10-year U.S. dollar bonds
at an amazing 911 basis points over U.S.
Treasuries, and paid its investment banker
(Morgan Stanley Dean Witter) a fee of 4
percent for the privilege. (The main buyers
of the Advance Agro bonds were U.S. junk bond
specialists.)

The same month, the Japanese firm
Toyota, which had 30 percent of the local car
market, announced it was suspending
production in Thailand. Since the crisis in
Thailand began in July, 58 finance companies
had been closed. Many Thai companies were
plundering their own assets, trying to spirit
them away before the banks took control.

Indonesia: No Dollars in Stock

Now we come to the land of the land of
Clinton-benefactor Mochtar Riady. Indonesia
is the world's fourth most populous country.
In Indonesia they blame the financial crisis
on the Koreans. The banks of South Korea
wouldn't roll over their short term loans to
borrowers in Indonesia. And that lead to the
crisis, to a scramble for dollars, the local
bankers say. As usual, the story starts in
mid-paragraph. "It all began when he hit
me," you say. But before that, you hit him.
And before that, he ran over your dog. And
before that . . .

The run on the rupiah started in August
1997. The central bank floated the currency
and it fell to an all-time low of Rp. 2950
against the U.S. dollar--a drop of about 20
percent from the beginning of the year. At
that time, the money-changers ran out of U.S.
dollars and gold, and George Soros was not
even there to drive them out of the temple.
"We don't have dollars in stock now," said a
spokesperson for the Jakarta money-changing
company Sinar Iriawan. "Dollar Rockets" read
the headline in a Kontan newspaper. It was
hard to tell if the reference was to price
altitude or to the explosive disappearance of
U.S. bucks.

The rupiah's fall--it continued to drop
to Rp. 4000 to the dollar--was not
surprising. The currency had long been
treated as the private spending script of
President Suharto and his relatives. A good
chunk of the banking industry was all in the
family, so to speak. In November the IMF was
called in for a $23 billion dollar
"stabilization program" (which includes the
contributions by the World Bank and Asian
Development Bank, and $5 billion from a
mysterious contingency fund). The IMF
demanded the closure of 16 banks. It didn't,
after all, want to be seen as pouring the
money directly into Suharto's pockets. But a
hue and cry nevertheless emerged from
Suharto's relatives. One son, Bambang
Trihatmodjo, who was a principal shareholder
in Bank Andromeda, filed a lawsuit against
the finance minister, claiming a plot to
discredit the family. Suharto's daughter,
Tutut, also joined the battle even though her
bank was not on the list of 16, as did
Suharto's brother-in-law, Probosutejo, owner
of the now-closed Bank Jakarta. Two of the
banks that were shut down were owned by the
brother of industrialist Eddy Tansil. Eddy
Tansil had escaped from jail in 1995 and
become a fugitive after being convicted for
defauding a state bank (Bank Bapindo) of $430
million.

Indonesian banks had also discovered
what the Japanese call zaitech, or interest
arbitrage. The free lunch in this case
involved borrowing U.S. dollars at 7 percent
interest and purchasing rupiah instruments
which paid 19 percent. They could earn 12
percent interest without investing any
capital! The profitability of the game
hinged, of course, on the assumption the
rupiah would not depreciate against the U.S.
dollar by more than 12 percent in the
interim, and that the issuers of the local
currency instruments would not default. But
for those who don't believe in free lunches,
it was inevitable that the rupiah's value
would adjust to eliminate the positive profit
that could be earned on zero capital
investment, or that there would be local
defaults, or both. And that's exactly what
happened. Both.

Beijinxed in Hong Kong

On Black Thursday, October 23, 1997,
Hong Kong's Hang Seng index fell over 1200
points, plunging below 10,000. That was the
largest point drop in its short 14-year
history. The stock market was down 35
percent for the month. On October 6 it still
stood above 15,000. But somehow commentators
failed to note the connection between the
deflating stock market and previously
inflated stocks like Beijing Enterprises--
which had been oversubscribed in an amount
equal to twice the Hong Kong money supply.
Stocks that can quadruple in a day can also
plunge to a quarter their previous valuation.
Red chips were down 50 percent for the month.
A new red chip, China Telecom, making its
public debut on Black Thursday, failed to
meet its issue price.

When China's President Jiang Zemin
arrived in Washington, D.C. in late October
1997, he discreetly avoided the subject of
China's most recent foray into markets. Yes,
like the pundits had said, the crash had put
some egg on China's face. But, unlike what
the pundits had believed, China had said
nothing and done nothing to preserve the
inflated value of red chips.

And suddenly foreigners were discovering
all sort of problems with Hong Kong. The
hotels were too expensive. Japanese
travelers, in particular, claimed they were
being gouged. Tourism from Japan was down 50
percent. Airline passengers on Cathay
Pacific were down 60 percent. Property was
too expensive. Land prices were as bad as
Tokyo's. One real estate mogul, Li Ka-shing,
was said to have lost a billion US dollars
the week of the crash. Hong Kong was
uncompetitive because the Hong Kong dollar
was overvalued. The Hong Kong/U.S. dollar
exchange peg (7.78 Hong Kong dollars to one
U.S. dollar) was in doubt, which in turn put
the external value of foreign investments in
Hong Kong in jeopardy. Better to switch into
U.S. dollars, people thought. High interest
rates were needed to defend the Hong Kong
currency. Low interest rates were needed to
keep up property values. What's a central
government to do? Singapore, anyone?

Hong Kong's chief executive (yes, Hong
Kong has a chief executive), Shanghai
businessman Tung Chee-Hwa--Hong Kong's answer
to Franklin Delano Roosevelt-- whipped out
his solution: a boost in health, education,
and welfare spending. And a massive social
program of home construction, so every Hong
Kong citizen could acquire his own home. (He
didn't say anything about a chicken in every
pot.) The fundamentals are fine, he said.
Meanwhile, the public, not so sure of all
this, made runs on various firms to redeem
vouchers. There was a run on the
International Bank of East Asia by customers
with savings account vouchers. There was a
run on the Saint Honore cake shop by holders
of cake vouchers. And those with gift
vouchers from the Whimsey Entertainment games
arcade center mobbed that establishment.

Hong Kong had long been ruled by a
British-Chinese oligarchy. It was never a
democracy. Recently, it has gone from
British rule to Chinese rule with scarcely a
free breathing space in between. Hong Kong
was founded by British traders as the
principal base for exporting opium into
China. When China resisted the trade,
Britain twice went to war with China, forcing
it to accept opium imports. The current
nostalgia over Hong Kong's British legacy
arises mainly from some of Britain's leading
families whose fortunes were built on the
drug trade. It was only in 1991 that Britain
allowed Hong Kong citizens to vote in direct
elections. Now a purely Chinese oligarchy
has taken control.

Nevertheless, Hong Kong became an
economic powerhouse because the government
stayed out of the economy. One could get
rich by hard work: taxes were only 15.5
percent. And there was no public social
security with its vaste distortions of
government-directed capital investments.
Instead, families saved for their retirement.
How long will it take for the Beijing
bureaucrats to turn Hong Kong into a replica
of the rest of China? How long before the
Shanghai stock market overtakes Hong Kong's?
Maybe not for a while. Hong Kong is China's
nexus to the expatriate Chinese community.
Chinese expatriates dominate trade and
finance everywhere in East Asia with the
exceptions of Korea and Japan. Chinese
expatriates hold the keys to foreign
investment in China. Maybe China won't suck
Hong Kong dry right away. Maybe.

Seoul Survivor

South Korea was once the mightiest of
the Asian tigers. South Korea grew more than
8 percent a year for three decades. South
Korea didn't need international bailouts like
those Latin American basket cases south of
the U.S. border. South Korea certainly
didn't need the IMF, everyone was saying. It
just needed, well, some help in stemming the
fall of the won, without having to blow its
own $30 billion (or was it only $20 billion?)
in foreign currency reserves in the process.
The central bank needed the dollars for
Korean companies: there were about $70
billion in foreign loans coming due by the
end of the year. Maybe the U.S. and Japan
could help out. South Korea, after all,
bought all those American and Japanese goods.
It was the world's 11th largest economy.

That was what was being said on
Wednesday, November 19, 1997. But why was
the won falling? If things were so
wonderful, why were the finances of the
chaebol, the conglomerates, in such bad
shape? Did it have something to do with the
continued overvaluation of the local
currency? Were foreign exchange reserve low
because the central bank had been selling
dollars too cheaply? The government
announced it would now widen the trading band
of the won, then at 1035 per U.S. dollar, to
10 percent either way from 2.25 percent up or
down. But, meanwhile, the opposition
candidate Kim Dae Jung said he would bring in
the hated IMF. So, only two days later, on
Friday, November 21, 1997, the South Korea
government of Kim Young-sam quickly decided
it too wanted IMF money in a big way: $20
billion worth. That number was chosen as the
arithmetic mean of the $17 billion provided
to Thailand and the $23 billion provided to
Indonesia. Twenty billion here. Twenty
billion there. Pretty soon we're talking
real money. But Korean newspapers called the
IMF assistance a "national shame" and "a loss
of economic sovereignty".

Over in Indonesia some of the bankers,
still fuming from the failure of South
Korea's banks to roll over short-term lines
of credit, clapped their hands in glee over
Korea's difficulty. In Washington, the IMF's
managing director, Michel Camdessus, also
rubbed his hands in satisfaction, since
handing out money was the source of his
social prestige and political power. (If he
had looked a little closer to home, the
Frenchman Camdessus would have noted that $20
billion was about what the Credit Lyonnais
bailout would cost.) But faces were more
sober in certain parts of Japan and Taiwan,
especially among exporters who competed with
Korean goods. If Korean goods were now
cheaper in U.S. dollar terms, these exporters
wanted like to see their own goods cheaper
also. They began talking about a desireable
depreciation of the Japanese yen and the
Taiwanese dollar.

Twenty billion dollars would be plenty,
said the new finance minister Lim Chang-yuel.
That was on Friday, Nov. 21. But by
Wednesday, Nov. 26, South Korea had decided
it really needed about $50 billion. That
would make it the biggest IMF bailout in
history, bigger than Mexico's. South Korea
was looking increasingly like one more basket
case. President Kim, Korea's answer to Roger
Babson, told the nation the problems were
caused by the selfishness of corporate
managers and workers. The managers borrowed
too much to satisfy their edifice complex.
The workers kept insisting on higher wages.

Underlying all the hoopla was the
unstated reality. Korea was no more a free-
market economy than the rest of Asia.
Companies could not sack workers. Foreign
banks could not own domestic banks. And
privileged companies were saved by government
intervention just like in the U.S. Sure,
Korea had committed itself to deregulation in
1995 in order to secure OECD membership. But
governments have a habit of maintaining tight
control of financial markets, in order to
siphon off resources, when times are good.
When the controlled environment begins to
fall apart, the government then agrees to
"deregulation" and washes its hands of the
whole affair--in hope that the ensuing
adjustment will be blamed on the market
mechanism, and not on the government. And why
not? The con worked in the U.S. It worked
in Japan. And it will work in Korea. One
thing is certain: Korea's banks have
problems. Non-performing loans are in the
neighborhood of 20 percent.

The Korean stock market had initially
rallied on the dubious assumption that IMF
money represented a gift. Then some
observers, not quite as brain-dead as the
rest, realized that the loans were expected
to be repaid. Korea already has one of the
most highly indebted corporate sectors in the
world. The fall in the stock market resumed.
On Monday, Nov. 24, the stock market dropped
7.2 percent. Korea interest rates rose to 16
percent, which was four times the inflation
rate. Samsung, the biggest of the chaebol,
said it could no longer obtain funding to
finish an automotive plant, nor would it be
able to finance the second phase of its
semiconductor plant in Austin, Texas. Coca-
Cola, meanwhile, feeling Korea's pain, seized
the chance to buy up cheap bottling plants
there.

Conclusion

It may be, as they say, that Asia is the
21st Century. Certainly you can see it
coming. Guests at the Imperial Hotel in
Tokyo can now receive their own private e-
mail address, as well as Internet and
newsgroup access, for the duration of their
stay. I'm sure Frank Lloyd Wright would have
approved. It's a little piece of the future
available to antediluvian nomads of the 20th
Century.

But getting the rest of the country--far
removed from the Imperial Palace--up to speed
will not come easily. It may not come at
all. It takes years to recover from an asset
bubble. And what can be said of Tokyo is
equally true of Hong Kong, Bangkok, Jakarta,
Seoul, and Beijing. The financial crisis
isn't over. The economic crisis isn't over.
On Nov. 3, James Wolfensohn, President of the
World Bank, said "the worst is over". He's
wrong. The worst has only just begun.

And this is the way Asia will enter the
21st Century. Not with a bang, but a
whimper.